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Monday, April 27, 2015

Here We Go Again?

The best of deals are made in the worst of times while the
worst deals are made in the best of times. We may be seeing a replay of this
mantra in the current M&A market. Coming off a deep post crash low, M&A
activity has sharply rebounded. This reflects a recovering economy, booming
capital markets and rising managerial and investor optimism. The activity is
driven by strategic buyers instead of private equity. The number of large deals over $5B
has also increased. Larger deals are froth with danger given the potential to
over pay and heightened integration problems associated with larger deals. The
buyer’s shareholders usually react negatively to the announcement of such
deals-and for good reason. Their track record underlies this reaction; namely,
50% of targets are disposed of within 10 years of the closing.

Yet, such deals are now receiving a largely positive
response from the buyer’s shareholders. Some possible explanations for this
development include:

1)Buyers are getting better at making acquisitions
(AKA this time is different).I have seen no evidence to support this
possibility.

2)We are early in economic and M&A cycles.
Thus as the cycle continues we will see mean reversion.

3)Shareholders are confusing size and growth with
value creation.

My concern is a toxic brew may be developing. This brew
includes investor bias towards growth combined with managerial overconfidence.
Board selection of CEOs favors over confident CEOs who are viewed as decisive
optimists. The process favors the lucky risk taker with a “successful” track
record -think of past Hewlett Packard CEOs Carly Fiorina and Leo Apotheker who
both engineered disastrous acquisitions.

So what can boards do to prevent future over priced ill
conceived acquisition disasters? It is unlikely subordinates will question CEO’s
who want to do the deal. What is needed is a strong experienced lead
independent director who can challenge-not second guess- large scale
transactions by considering the following:

1)Does due diligence support the deal’s thesis?

2)Is there a detailed integration plan based on
the strategic rationale of the deal?

The real key is to run alternative stress case projection
scenarios reflecting what could go wrong not just what is expected. A useful
approach is to consider what could cause your deal to fail financially in the
next few years. If you cannot think of any - then think again - they are out
there.

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About MergerProf

In addition to their day jobs, Joe and Ralph teach acquisition finance at the Amsterdam Institute of Finance. This blog was created in the summer of 2012 as a tool for those interested in acquisition finance and related material. Admittedly, we define related material broadly to include mergers, private equity, banking, governance, deal making and, well, finance in general. We hope you will enjoy and contribute, critiquing, expanding and providing your own examples related to the posts. We encourage you to join us in this adventure and, for some of you, to see you in Amsterdam, New York or Philadelphia.